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Are Record Stock Buybacks Too Much Of A Good Thing?


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By any measure, $104 billion is a lot of money. That's the dollar value of share buyback announcements made in February -- the largest monthly figure since these flows were first tracked 20 years ago.

It was also nearly double the amount from a year earlier, according to money flow tracker TrimTabs Investment Research. (Companies make share buyback announcements throughout this year, but February is typically the high watermark as companies release full-year financial results.)

Companies in the S&P 500 spent $564.7 billion on share repurchases over the past 12 months, which was a year-over-year increase of 18%, according to FactSet Research. In fact, 72% of all companies in the index bought back shares in the fourth quarter of 2014.

Make no mistake, the powerful waves of buybacks are a clear positive for stocks -- in the near-term. For proof, look no further than the five-year chart for the PowerShares Buyback Achievers ETF (NYSE: PKW ).

Simply put, the more than $2 trillion in cash that has been returned by S&P 500 companies since 2009 has been a key factor behind the bull market's extended run. Said another way, a steady reduction in shares outstanding has helped earnings per share ( EPS ) grow at a robust rate, surely more than the tepid global economic environment would normally dictate. And the fact that the recent wave of fresh buyback commitments should underpin even greater reductions in shares outstanding means this bull market is likely to continue.

Nobody is disputing that buybacks can be a good thing for companies and shareholders (the operative word being "can"). In fact, we at StreetAuthority are such believers in the power shareholder-friendly practices like buybacks can have on total returns; we have an entire premium newsletter devoted to the idea: Total Yield . Indeed, my colleague Nathan Slaughter, Chief Strategist of this newsletter, has been able to find some of the most impressive gains we've seen by investing this way.

But another set of voices is emerging on the topic. And these voices express concern that companies have become so enamored with share buybacks that they are losing sight of the need for long-term investments in operations.

As Euro Pacific Capital's Peter Schiff recently said, "Money spent on buybacks is not available to purchase new plant and equipment, to fund research and development, or to spend on marketing and logistics. In that sense, buyback spending generates current earnings at the expense of future earnings."

Meanwhile, companies in other regions still have a primary focus on long-term investments, and not buybacks. Analysts at Citigroup note that for every dollar spent on buybacks in Japan, another $5 is spent on business investment (also known as Capital Expenditures or "CapEx").

In Europe, companies spend twice as much on CapEx as they do on buybacks. In the United States, funds earmarked for CapEx and buybacks are roughly the same. The relative emphasis in the United States is understandable. "For now, the market wants cash cows not CapEx addicts," add Citigroup's analysts.

Even when a company's board would like to retain a focus on long-term investments, there is so much pressure to pursue buybacks that real harm can be done. For example, auto maker General Motors Co. (NYSE: GM ) has been working for the past half-decade to get its fiscal house in order. Auto sales -- and operating cash flow -- are impressive right now, but GM and its peers know that the auto industry has had an impressive run of annual sales growth, and the day will surely come when auto sales hit an air pocket.

So you can imagine GM's reticence to use its cash on anything other than product development, pension funding, marketing expenses and other financial needs. Still, the company now plans to buy back billions of its own stock, a move made in response to demands from activist investors.

Never mind that GM still has not fully funded its pension, that it is on the cusp of new contract discussions with labor unions, that it is still dealing with the costly fallout of a fatal ignition switch problem, and as noted, may eventually be looking at a fresh pullback in auto sales. In that light, pushing GM into a share buyback program almost seems reckless.

The key factor to consider: Can companies pursue major buyback programs and still ensure that the right investments are being made for long-term growth?

Dow component 3M Co. (NYSE: MMM ) points the way to how things should be done. In his look at the company in the January issue of Total Yield , Nathan Slaughter notes that 3M has spent a cumulative $11 billion on buybacks in the past two years. Yet the company is still committing funds to maintain 3M's innovative product pipeline.

As Nathan recently wrote, "3M has been plowing a nickel of every dollar in sales back into research to develop the breakthrough new products and technologies of tomorrow. I'm glad to see that management is aiming to up its R&D commitment (to 6% of revenues) in the years ahead to stay competitive."

Risks To Consider: Although I'm cautioning about some companies that seem to be buying back stock at the expense of all else, as long as the stock market rises ever higher, share buyback announcements are likely to be applauded by investors.

Action To Take --> Share buybacks are generally a good thing, but they can be taken too far. Companies -- and the activists that pressure them -- are often spending almost all of their cash flow on dividends and buybacks, but that invites the risk of longer-term under-investment in the core business. As you look to invest in companies (like Nathan's 3M pick) with an impressive, shareholder-friendly track record, look more deeply into the financial statements to ensure that R&D spending as a percentage of sales is being maintained.

Share repurchases -- done the right way -- are such a powerful tool that StreetAuthority devoted an entire newsletter to identifying shareholder-friendly firms that pay dividends and buy back shares . These stocks, which we call Total Yield stocks, have proven to beat the market -- even during the 2008 financial crisis and the dot-com bubble -- and serve as reliable income investments. To find out more about Total Yield investing, click here .

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

© Copyright 2001-2016 StreetAuthority, LLC. All Rights Reserved.



This article appears in: Investing , Investing Ideas , Stocks
Referenced Symbols: EPS



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